Spending Spree Zaps SAP

German software giant SAP ( SAP) surprised Wall Street earlier in the month with a warning that it would not meet fourth-quarter revenue targets .

On Wednesday, the company announced another surprise when reporting its fourth-quarter results: It will sacrifice a point of operating margin to bolster its efforts in the small- and medium-business market.

The latest news didn't please Wall Street. In recent trading shares were off $3.37, or 6.7%, to $46.70. Since the warning on Jan. 11, the stock has lost about 16% of its value.

SAP will spend 300 million euros to 400 million euros over the next eight quarters to develop an application suite targeted at businesses with 100 to 500 employees. The money will go to R&D, marketing and sales and should start paying off in early 2008, says Bill McDermott, CEO of SAP Americas. "This market is wide open. We believe the new suite will generate $1 billion in revenue by 2010," he said during an interview.

As a result, the company expects full-year operating margin for 2007 to be between 26% and 27%, compared with last year's 27.3%.

SAP is locked in a ferocious battle with Oracle ( ORCL) in the business application software market. The two companies routinely take shots at each other during conference calls, and McDermott claimed that SAP gained at least 3 points of market share in the last calendar year -- a contention Oracle disputes.

SAP already has several products aimed at the very low and the high ends of the SMB (small and medium business) market. The new suite, whose name has not been announced, falls in between those products.

The news of the major investment was something of a surprise, since SAP has been touting its efforts in the midmarket for some time.

"This spending plan is a total surprise and highlights the fact that SAP has been late with its midmarket product," John Segrich, an analyst at JP Morgan in London, told Dow Jones Newswires. "It will be the first time in seven years that SAP's operating margin will drop."

It's worth noting, however, that while software companies are under pressure from the marketplace to innovate, Wall Street gets nervous when the bill for that innovation is presented. Microsoft ( MSFT), for example, took a hit last year when it announced an expensive effort to boost its competitive position in the fast-growing markets for online advertising and search.

SAP said it expects full-year software and software-related services sales to increase by between 12% and 14% in constant currency terms, compared with 12% last year.

SAP earned 799 million euros ($1.04 billion) in the three months through Dec. 31, up from 619 million euros in the same period a year earlier. Revenue in the quarter rose 7% to 2.952 billion euros ($3.82 billion).

Worldwide software sales rose 7% to 1.26 billion euros ($1.64 billion). While they increased 13% in Europe and the Middle East, they were flat in the Americas and rose by only 2% in the Asia-Pacific region.

However, the sales numbers are a bit misleading since SAP was hurt by a sharp fall in the value of the dollar against the euro. In constant currency, software license sales in the Americas grew by about 10% and by 15% in the U.S., McDermott said.

SAP also said it cut 30 million euros ($39 million) from its third-quarter software revenue sales after it amended a contract with a U.S. customer, which it did not identify.